On April 23rd, the Supreme Court (SCOTUS) heard oral arguments on the issue of credit bidding that has been discussed on Distressed Debt Investing a number of times: Credit Bidding and the Supreme Court and Advanced Distressed Debt Lessons: Credit Bidding. Credit bidding is relevant to distressed debt investors for a number of reasons and can swing who gets what (most importantly, the fulcrum security) in a Chapter 11 proceeding. With the contrary rulings in the Seventh Circuit as compared to the Fifth Circuit and Third Circuit (probably the most famous for distressed investors: Philly News), it was a matter of time before SCOTUS took the issue up. Some have called this the most important business bankruptcy case in nearly 15 years.
For those that would like to see the transcript of the hearing, which is a fascinating (but complex) reading, can find it here: SCOTUS Hearing Transcript re Credit Bidding
The case at issue specifically in from of the Court is RadLax Gateway Hotel, LLC v Amalgamated Bank. In the case the Seventh Circuit ruled with Amalgamated Bank that River Road bankruptcy case (Northern District of Illinois) could not be confirmed because it did not allow Amalgamated Bank to credit bid its claim. River Road argued that because Amalgamated Bank was receiving "indubitable equivalent" value of its collateral (a term not defined in the code) it did not need to be allowed to credit bid. The bankruptcy court shot this down quickly. The Debtors appealed and the Seventh Circuit ruled with the bankruptcy court, specifically pointing out in their ruling they disagreed with the rulings in the Fifth and Third Circuit.
For those that do not know, an amicus brief is information offered to the court by a non-party in the case. For the SCOTUS hearing, an amicus brief was filed, in support of the secured creditor's position (i.e credit bidding should be allowed), by an impressive group including the LSTA, the American Bankers Association, Mortgage Banks Association, to just to name a few. In addition, the United States filed an amicus brief in support of lenders position.
A favorite point of mine in the United State's amicus brief: "
The ability of a federal agency to bid cash is therefore strictly circumscribed by the scope of its congressional appropriation. But because federal law also requires the United States to take a lien on collateral when it extends certain kinds of loans, the United States is often a secured creditor in bankruptcy proceedings...If the United States and federal agencies are unable to bid cash at the sale of their collateral due to a lack of appropriated funds, and are prevented from exercising their statutory right to credit bid, the auction price of such asset would be depressed, and the United States would ultimately receive less value for its security interests"The LSTA, in a press release stated:
"The Loan Syndications and Trading Association, joined by nine other trade associations, submitted an amicus brief to the US Supreme Court in the RadLAX Gateway Hotel case, arguing that secured creditors cannot be prevented from “credit bidding” in an auction of their collateral in a “cram down” plan of reorganization. The LSTA argues that credit bidding is a critical tool for protecting a secured creditor from having its collateral undervalued. If the creditor is not satisfied with the competing bids, it can obtain the property by bidding more, using the amount of its unpaid debt as currency in the auction.
"In this case, the debtors are attempting to steer the collateral to a bidder with insider ties at a substantial discount at the expense of the secured creditor," commented Elliot Ganz, Executive Vice President and General Counsel of the LSTA. "The Bank-ruptcy Code is specifically designed to prevent this type of mischief and ensure that secured creditors get the value they are entitled to receive."While its always hard to tell which way the court will rule, the transcript reads like SCOTUS is leaning towards the lenders position, with debtors counsel taking a bit of a flaying by most of the 8 judges present (Kennedy had recused himself). A world without credit bidding would completely flip upside down what I had been taught to view bankruptcy (i.e. loan to own works because the credit bid has significant leveraging power) and distressed investing. If I had to make a bet, I'd say that management teams of Chapter 11 debtors would rather not have credit bids: i.e. you create the equity at a lower valuation (all else being equal) because lenders will rarely cash bid anywhere near their credit bid (good money after bad). I'd expect we'd hear back soon from SCOTUS on the case. This has been a fascinating one to watch over the past few years.